When it comes to a buy-sell agreement there are myriad ways to establish the valuation method. Insert a formula? Insert a hard-coded price? Maybe name an appraiser directly in the agreement? Each of course has advantages and disadvantages, but one variation that we run into fairly frequently is what we will call the “Three Appraiser” Method.
Broadly speaking there are two ways to implement the method:
- Option 1: Buying and Selling Party each retain an independent appraiser. If the two appraisals are within a predefined percentage of one another, the outcomes are averaged. If they exceed the amount, then a third appraiser is retained (hence “3 Appraiser Method”). It’s often the case that this result is then averaged with the next-closest result.
- Option 2: Buying and Selling Party each nominate an independent appraiser. Those two appraisers will then jointly nominate a third appraiser to then actually perform the valuation.
When considering Option 1, the issue that immediately jumps off the page is cost. There’s a pretty decent chance that the parties are paying for three duplicate pieces of work.
Option 2 might seem straightforward until you consider the difficulties of convincing a professional to pick another firm to perform the work that they could be doing. We’d suggest it would be be difficult at best to get someone to perform this task without compensating them- typically at a minimum of a couple of hours at their full billing rate. Beyond that issue, have you ever tried to get two competing professionals to agree on an issue? You may have the same frustration coaxing dueling valuation firms trying to jointly nominate the third.
A Better Option
Our preference, in lieu of the Three Appraiser Method, is to use a single appraiser and, ideally, conduct an initial appraisal PRIOR to the actual need for it. When? Engage a professional appraiser when the Buy-Sell is created and value the company immediately. Then, repeat on an annual or semi-annual basis. Early buy-in from shareholders on methodology and approach, as well as an ongoing understanding of value, will mitigate many, many problems down the road.